Wednesday, March 2, 2011

Have you heard about IR35?

No one likes paying taxes. To get around paying taxes on wages, many people employed ways to pay little tax as possible on their wages. Employees of small businesses favored being employees of a contracting company, which subcontracts hired their labor out to other company. In effect, the collected waged in form of dividends which are not subjected to taxes.

Many IT professionals began quitting their permanent jobs and return to do the same job as a contractor through a limited company. By being independent contractors, these people are able to save a lot of money on taxes and even get paid more for the same job they were doing previously.

Soon, the small business owners saw this opportunity and so became freelancers who started drawing income from their limited companies in form of a small salaries and large dividends. Since large companies received large tax allowance which common working individuals are not entitled to, individuals treating themselves as companies can actually make more tax-free money. They even spread out ownership among family members to keep everyone in a lower tax brackets.

Hence IR35 was coined to ensure that the freelance contractors would be subjected to the same tax rules as a person carrying out the same task under regular employee conditions.

Inland Revenue looks at the overall work set up to classify if person is ‘employed’ or ‘self-employed’ subject to the IR35 rules. It defines an employed person as someone who works from 9AM-5PM on a client site who has not provided own tools to complete tasks and is thereby subject to the IR35 rules. On the other hand, it defines a self-employed or contractor an one who fulfills for multiple clients in the comforts of his home using his own equipment to complete the job required.
Employment contracts falling covered by the IR35 rules, receive 5% allowance to cover intermediary expenses on top of pension contributions and contractor insurances. Their income comes in form of deemed payments.

In effect, the tax benefits of freelancing through a personal limited company were greatly reduced when the IR35 law was enacted in 2000.

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